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High yield: the full spectrum
High yield bonds are more than just a subset of fixed income, they are a microcosm of investing. It is this characteristic that is increasingly putting them on investors’ radar. By Tom Ross
Driving the demand has been the search for yield. Central banks remain committed to keeping interest rates low and this has driven investors further along the credit spectrum. In Europe, with yields in negative territory on many sovereign bonds and meagre yields on higher quality investment grade corporate debt, high yield is one of the few areas in fixed income markets that currently offers yields above inflation. Ultimately, those high yields act as a form of compensation for the NUMMER 3 | 2021
higher default risk that accompanies bonds with lower credit ratings. Yet it is this aspect of risk that makes them attractive. High yield bonds simultaneously share the key characteristics an investor expects of bonds, namely a regular income and the prospect of par value returned at maturity, with a degree of equity sensitivity to corporate conditions that reflects the higher risk of default. This risk premium feeds through into credit spreads that lead to high yield bonds on average, historically offering upwards of 300 basis points more in yield than government bonds of similar maturity.1 The higher yields on bonds, together with relatively short maturities, means that high yield typically has a lower duration (sensitivity to interest rate changes) than investment grade credit and
government bond markets – a potentially valuable characteristic at a time when inflation fears are heightened.
Tom Ross Corporate Credit Portfolio Manager at Janus Henderson Investors
A welcome expansion It might be thought that low yields would encourage companies to borrow heavily, yet the high yield market has grown at a relatively restrained rate. In fact, prior to the COVID-19 crisis, the size of the high yield market had been static for several years. Financial commentators used to fret about the growing size of the BBB market (the lowest section of investment grade) prophesying a tidal wave of Fallen Angels (investment grade bonds downgraded into high yield). For high yield managers, this was less of a threat and more of an opportunity. The tidal wave never transpired. There were a
PHOTO: ARCHIVE JANUS HENDERSON ILLUSTRATION: SHUTTERSTOCK
Occupying the centre ground between investment grade bonds and equities from a risk-return perspective, sub-investment grade bonds – or high yield bonds as they are more commonly known – have become increasingly sought after by investors.
